Subprime borrowers, securitization and the transmission of business cycles

One of the roots of the recent global financial crisis has been seen in the design of subprime mortgage contract leading to high sensitivity of such type of loans to house price changes. The market of subprime loans, especially in the last years preceding the crisis, has been highly financed by securitization. The paper investigates how borrowers with subprime characteristics influence the transmission mechanism of business cycles in the economy and whether the securitization of subprime loans has a positive effect on the economy. The formal setup is a DSGE model with different types of borrowers and banks acting as financial intermediaries, in which households and entrepreneurs borrow against housing collateral. The economy is subject to four shocks: monetary, inflationary, preference and technology. It is shown that alone the existence of subprime borrowers does not make the economy more responsive to different shocks at the aggregate level (it has only redistributional effects) and that under certain circumstances the securitization of subprime loans (in form of residential mortgage backed securities) may lead to amplification of the business cycles

Subprime borrowers, securitization and the transmission of business cycles

One of the roots of the recent global financial crisis has been seen in the design of subprime mortgage contract leading to high sensitivity of such type of loans to house price changes. The market of subprime loans, especially in the last years preceding the crisis, has been highly financed by securitization. The paper investigates how borrowers with subprime characteristics influence the transmission mechanism of business cycles in the economy and whether the securitization of subprime loans has a positive effect on the economy. The formal setup is a DSGE model with different types of borrowers and banks acting as financial intermediaries, in which households and entrepreneurs borrow against housing collateral. The economy is subject to four shocks: monetary, inflationary, preference and technology. It is shown that the existence of subprime borrowers makes the economy more responsive to different shocks and that under certain circumstances the securitization of subprime loans (in form of residential mortgage backed securities) may lead to amplification of the business cycles

Double liability in a branch banking system: Historical evidence from Canada

We investigate the effects of the abolition of double liability requirement imposed on bank shareholders in Canada on bank risk-taking and lending behavior. Under the double liability rule, the shareholders of a bank were liable up to twice the amount of their subscribed shares in the case of bankruptcy. With the establishment of the Bank of Canada in 1934, the double liability requirement became less stringent and depended on the pace of the redemption of notes in circulation issued by the individual chartered commercial banks. Using historical balance sheet and accounting data, we show that the abolition of double liability was not accompanied by increased bank risk taking in Canada. Our findings are consistent with the literature that focuses on uniform regulations and nationwide branching as key financial stability elements in Canada

Essays on Business Cycles

The recent Great Recession has renewed interest in the role of financial markets and credit in the economy, as well as in the boundaries of monetary, macroprudential and fiscal policies that impact macroeconomic developments and may influence business cycles. In the first two chapters of this thesis, I devote my attention to the role of credit backed by real estate in the economy. In the first chapter of the dissertation, I investigate the role of subprime securitization on U.S. business cycles in order to provide a better understanding of secondary financial markets and their impact on macroeconomic variables. I show that due to interbank linkages and banks facing binding capital requirements, the existence of subprime securitization has ambiguous effects on business cycle fluctuations, depending on who is the final buyer of securitized assets. The main contribution of this chapter is the incorporation of some aspects of financial modelling (mortgage backed securities) into an otherwise standard macroeconomic model. In the second chapter, I study the effects of monetary and macroprudential policies on the economy with a special focus on housing prices in the U.S. and in the U.K. A negative monetary shock leads to a decline in house prices in both countries. The impact of a negative credit shock on house prices remains unclear for U.S. data but is negative for the U.K. Both shocks generally tend to be more powerful in the U.K. than in the U.S., which might be due to the different structure of mortgage contracts in both countries. The main contribution of this chapter is the analysis of the effectiveness of different policy measures aimed at influencing the house price dynamics in an economy in which housing purchases are mainly financed through credit. The third chapter of this dissertation features a real business cycle model with a climate change externality and addresses the design of optimal environmental instruments. The analysis of the optimal policy instrument to control CO2 emissions under uncertainty arising from business cycles has also gained relevance in the aftermath of the financial and economic crisis of 2008, particularly in the context of reforming the European Union Emissions Trading System (EU ETS). The main contribution of this chapter is extending Weitzman's results to a general equilibrium framework under uncertainty and showing that the main intuition behind the price-quantity argument holds in the “idealized'' world in which the regulator has access to state-contingent environmental instruments

Predictors of Bank Distress : The 1907 Crisis in Sweden

This paper contributes to literature on bank distress using the Swedish experience of the in- ternational crisis of 1907, often paralleled with 2008. By employing previously unanalyzed bank-level data, we use logit regressions and principal component analysis to measure the im- pact of pre-crisis bank characteristics on the probability of their subsequent distress. The crisis was characterized by “creative destruction,” as those banks with weaker corporate governance structures, wider branching networks, operating with lower cost efficiency were more likely to experience distress. We find that poor credit allocation rather than foreign borrowing, as often stressed, were associated with ultimate demise

Book review: Behavioural economics and finance

"Behavioural Economics and Finance. Michelle Baddeley. Routledge. 2013. --- Standard models in economics usually assume that people are rational, self-interested maximisers, effectively co-ordinated via the invisible hand of the price mechanism. Whilst these approaches produce tractable, simple models, they cannot fully capture the uncertainties and instabilities that affect our everyday choices. Behavioural Economics and Finance brings economics and finance together with psychology, neuroscience and sociology, aiming to introduce the reader to some of the key concepts and insights from this rich, inter-disciplinary approach to real-world decision-making. Reviewed by Anna Grodecka

Book review: Living economics: yesterday, today, and tomorrow

In Life after New Media, Sarah Kember and Joanna Zylinska make a case for a significant shift in our understanding of new media. They argue that we should move beyond our fascination with objects such as smart phones to an examination of the interlocking technical, social, and biological processes of mediation. Kim Toffoletti believes this ambitious project succeeds in convincing us to think differently about new media, and makes a key intervention into the fields of technology and media studies, by calling attention to the complexities that arise in the processes, interactions and encounters with media that confound dichotomous ways of interpreting media objects

Book review: wrong: nine economic policy disasters and what we can learn from them by Richard S. Grossman

In recent years, the world has been rocked by major economic crises, most notably the collapse of Lehman Brothers, the largest bankruptcy in American history, which triggered the breathtakingly destructive sub-prime disaster. What sparks these vast economic calamities? Why do our economic policy makers fail to protect us from such upheavals? Anna Grodecka reviews Richard S. Grossman’s contribution to the literature, and finds this an insightful and accessible read, especially recommended for economics students

Book review: big ideas in macroeconomics: a nontechnicalview by Kartik B. Athreya

In this book, Kartik B. Athreya aims to offer a nontechnical description of prominent ideas and models in macroeconomics, arguing for their value as interpretive tools as well as their policy relevance. Anna Grodecka finds that the book has much more to offer those interested in microeconomics and recommends this useful read to economics researchers and students